The Securities and Exchange Board of India (Sebi) has said that despite tightening norms to lift the veil around the ‘opaque structure’ of Foreign Portfolio Investors (FPIs), the regulator has faced a wall since entities actually controlling FPIs are in jurisdictions which leave ambiguity around entities that have economic interest in FPIs, but no ostensible control.
An expert committee appointed by the Supreme Court had in May had said that the difficulties experienced by Sebi in identifying holders of economic interest were at least partly because of the repeal, in 2019, of the 2014 provisions on “opaque structures”. The expert committee was set up to investigate if there was violation of the minimum public shareholding norms and if there was a failure to disclose transactions with related parties with respect to the allegations raised by the Hindenburg Report.
In its affidavit submitted in the Supreme Court Monday, Sebi said that with the regulatory changes governing FPIs in 2018 and 2019, it had tightened the disclosure requirement for beneficial owners (BOs) of FPIs. Further, according to the regulator, in some cases entities having economic interest in an FPI are in jurisdictions where the equivalent PMLA (Prevention of Money Laundering Act, 2002) regulations require BO identification only on the basis of control or ownership.
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“Thus, the investment manager/ trustee etc. acting through arrangements such as voting shares/ management shares, is then identified as the BO of the FPI. Consequently, while in compliance with the regulations, the actual investing constituents with economic interest may not be identified as BOs of the FPI. This issue is further accentuated if holdings of such investors are spread through multiple FPIs. FATF (Financial Action Task Force) has also identified the same as a global challenge,” Sebi said.
Sebi said every FPI had to mandatorily disclose all their BOs upfront, and in the absence of any natural person BO, identify an SMO (Senior Managing Official) as the BO, Sebi said. With this, the dispensation under FPI 2014 regulations that allowed certain FPIs to register, inter-alia, on the basis of an undertaking to provide BO details when sought, was no longer available. In essence, the ability of Sebi to seek additional details as required to ensure compliance with extant regulations existed both during the 2014 regime, and continue to exist currently under the 2019 regulations. There has been no relaxation of any kind on this front either, Sebi said.
The expert committee had said market regulator Sebi “suspects wrongdoing” on the ownership of FPIs but it was unable to pinpoint the violations. However, in a dig at the regulator’s policy, the committee said, “it appears that the legislative policy stance of Sebi on the ownership structure of FPIs has moved in one direction while the enforcement by Sebi is moving in the opposite direction.”
Sebi has been investigating the matter since October 23, 2020 whereas the Hindenburg Report was published on January 24, 2023. It is, however, for the Sebi to conclude the investigations in accordance with law within a precise time frame, the committee said.
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Considering the challenges and to address issues related to minimum public shareholding, Takeover Regulations and Press Note-3 (PN3), Sebi Board in meeting dated June 28, 2023 has approved the proposal for additional granular disclosures to the last investor from specified types of FPIs that either hold more than 50 per cent of their AUM in a single corporate group, or have a total AUM of over Rs 25,000 crore subject to certain exemptions.
The regulator also differed from the views of the expert committee on dealing with allegations of related party transactions (RPTs) – arrangements or deals between two entities which have a common interest or a relationship – by companies. The Hindenburg Report had questioned the appropriateness of over 6,000 RPTs in the Adani Group, and also pointed to 10 RPTs that were not disclosed, but ought to have been.
Sebi said if a scheme to circumvent regulations is identified, the presence of a long-standing relationship in it can lend credence to the allegation of violation. The expert committee had raised a question regarding burdening an arm’s length business relationship as being an RPT for no reason other than having been a long-standing relationship.
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The market regulator also said that if a company circumvents the provisions of a law, it does not take enforcement actions based on amendments that are undertaken subsequently; rather it applies the extant law on circumvention. The expert committee had said that Sebi cannot assail past transactions as being in violation of law stated as not being in force when the transactions were made. “Invoking the spirit of the law would not suffice to pursue a credible means of investigation into the matter, keeping a cloud over the transactions,” it had said in its report submitted to the Supreme Court in May.
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Sebi also differed from the expert committee’s observations relating to timelines for investigations and proceedings. “Prescribing timelines for initiation of investigation and proceedings may not be appropriate as the Board is mandated to prima facie opinion to appoint an Investigating Authority… this is dependent on many factors including when the alleged violation was observed/ came to the knowledge of SEBI, analysis of the information and material available on record etc.”
Noting that the nature, scope and complexity of cases in the securities market vary significantly, and “reasonable time” to complete investigation would depend on the facts of each specific case and availability of information, the regulator argued that prescribing timelines may compromise the quality of investigation. “Additionally, completion of investigation also depends on various factors including the information provided by the persons being investigated, whether such persons are cooperative or not, availability of information from cross border financial institutions, etc. This may create constraints for the Board to function efficiently and also increase litigation,” SEBI said.
The expert committee had recommended stipulation of specific timelines for initiation and completion of investigations, initiation of proceedings, and disposal of settlement and proceedings. “Some elements of the timeline may be directory and other elements may be mandatory,” it had said.